Investing in Stocks
Chapter 12
Lesson 12.1 Evaluating Stocks
I. Characteristics of Stock
A. Nearly 50 million people in the U.S.
own stocks
1. There are more than 34,000 public
corporations from which to choose
2. Public corporation—a company
whose stock is traded openly on
stock markets
3. Stockholders—owners of a
corporation
Characteristics of Stock
4. Dividends—the part of a corporation’s profits
paid to stockholders
5. Capital Gain—increase in the value of the stock
above the price initially paid for it
6. A capital gain becomes profit only when you sell
the stock.
7. Stockholders can lose all they invest should the
company fail
8. Stocks are traded in round lots or odd lots
a.
Round lot—multiples of 100 shares
b.
Odd lot—fewer than 100 shares
(usually higher per-share fees)
B. Common Stock
1. Common Stock—type of stock that pays a
variable dividend and gives the holder voting
rights.
2. Board of directors—elected by stockholders to
guide the corporation, decides the amount of
dividend
3. Common stockholders may vote on major
policy decisions. One vote per share owned
4. May vote in person or by proxy—a
stockholder’s written authorization to transfer
his/her voting rights to someone else (usually
company mgr)
C. Preferred Stock
1. Preferred Stock—type of stock that
pays a fixed dividend and carries no
voting rights
2. Always earn stated dividend, paid
ahead of common stockholder
3. Less risk, usually less return
II.
Classifying Stock Investments
—Income, Growth, Blue Chip,
Defensive, Cyclical
A. Income vs. Growth Stocks
1.Stocks that have a consistent history
of paying high dividends are known as
income stocks.
2.Investors choose income stocks in
order to receive current income in the
form of dividends
3.Preferred stocks usually the choice of
retired people and others who want
income from dividends.
Income vs. Growth Stocks
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4. Growth stocks—stocks in
corporations that reinvest their
profits into the business so it can
grow, usually pay little or no
dividends
5. Investors buy growth stocks for
future capital gains, growth stocks
are long-term investments
B. Less Established vs.
Blue Chip Stocks
1. Stocks in young, small corporations
have higher overall risk than stocks of
companies that have been successful for
many years
2. Blue Chip Stocks—stocks of large, wellestablished corporations with a solid
record of profitability (IBM, Coca-Cola)
3. Blue chip stocks are a conservative
investment with relatively safe, stable,
but moderate returns.
C. Defensive vs. Cyclical
Stocks
1. Defensive stocks—one that remains
stable and pays dividends during an
economic decline, usually have a history
of stable earnings. (Utilities, drugs, food,
health care)
2. Cyclical stocks—do well when the
economy is stable or growing, but do
poorly during recessions—when the
economy slows down. (Airlines, resorts,
manufacturing companies, agriculture)
III. Determining a Stock’s
Worth
A. Stock Value
1. Stock certificate states the number of
shares you own, the name of the
company, the type of stock (common
or preferred) and the par value—an
assigned (and often arbitrary) dollar
value
2. Par value has nothing to do with a
stock’s market value—the price a
stock is bought and sold in the
marketplace
Determining a Stock’s Worth
3. Undervalued stocks are worth more than
the price for which they are selling, make
good bargains for investors, but can be
dangerous for business. Corporation can
be vulnerable to a takeover.
4. Overvalued stocks are selling at a price
that is not justified by their earnings
potential. Risky for the investor, price
likely to drop.
B.
Stock Price—several factors affect
the price you will pay for a share of
stock
1. The Company—price will continue to
rise if the company is in a good financial
position.
2. Interest Rates—when interest rates fall
below the current rate of inflation,
people buy more stock and stock prices
rise
Stock Price
3. The Market—if a company is in a popular
industry and its products or services are
selling well, its stock price will rise. If the
demand for its products or service
declines, the price of the stock will
decrease.
4. Earnings per Share—a corporation’s after
tax earnings divided by the number of
common stock shares outstanding.
Stockholders use earnings per share as a
measure of profitability.
C. Return on Investment
1. ROI—the profit you earned on
the stock as a percentage of
the total cost of buying the
stock
2. Must take into consideration
dividends, capital gain,
commission
3. Divide profit by cost.
Lesson 12.2 Buying and
Selling Stock
I. The Securities Market consists of the
channels through which you buy and
sell securities (stocks and bonds).
Need a trading agent.
A. Securities Exchanges—a
marketplace where brokers who are
representing investors meet to buy
and sell securities
1. NYSE—New York Stock
Exchange; AMEX—American
Stock Exchange, both in New
York City. To be listed, company
must meet a minimum
Securities Exchanges
2. Floor brokers buy and sell stocks
on the trading floor of the exchange
3. All buying and selling is done
around trading posts, 90 different
stocks assigned to each post,
display units which list info about
stocks sold.
Securities Exchanges
4. Orders received at a brokerage firm are phoned
or sent by computer to that firm’s booth at the
exchange, message given to floor broker to
carry out, transaction concluded.
5. Exchange is a form of auction market where
buyers and sellers are brought together to trade
securities. Stock is sold to the highest bidder
and bought from the lowest seller. Securities
listed with NYSE are traded only during official
trading hours—9:30 am to 4 pm, New York time,
M—F
B. Over-the-Counter Market
1. OTC—when securities are bought
and sold through brokers but not
through a stock exchange
2. The over-the-counter market is a
network of brokers who buy and
sell the securities of corporations
that are not listed on a securities
exchange.
Over-the-Counter Market
3. Do not deal fact-to-face, trades are
completed by telephone, and a
computerized system displays current
price quotations on a terminal in a
broker’s office.
4. Brokers use an electronic quotation
system called the NASDAQ.
5. To be listed, companies must have
issued at least 100,000 shares of stock
worth $1 million.
C. Bull and Bear Markets—
Cycles of the stock market
1. Bull market—is a prolonged period of rising
stock prices and a general feeling of investor
optimism
2. Bear market—a prolonged period of falling
stock prices and a general feeling of investor
pessimism. Develops when investors become
negative and the overall economy and start to
sell stocks. Bear markets are usually short and
savage.
Bull and Bear Markets
3. Bull market often lasts three to four
times as long as a bear market
4. To make a profit, buy when the price
is low and sell when the price is
higher. Research individual stocks
to judge which are likely to earn a
profit.
II.
Investing Strategies (Speculator or
day-trader—short term; Investor—
long term)
A. Short-Term Techniques
1.
Playing the stock market—
when you buy and sell
stocks for quick profit
2. Buy on Margin
a. You can borrow money from your broker
to buy stock if you open a margin account
and sign a contract called a margin
agreement.
b. Leverage—the use of borrowed money to
buy securities
c. You are betting that the stock will increase
in value
d. If the value of the stock does not increase,
you will have to make up the difference
e. Margin call—the investor must pledge
additional cash or securities to serve as
collateral for the loan or it is sold to pay
off the loan
3. Sell Short
a. Short selling is selling stock borrowed
from a broker that must be replaced at
a later time. You borrow a certain
number of shares from the broker,
you then sell back the borrowed
stock, knowing that you must buy it
back later and return it to the broker.
You are betting that the price will drop
so you can buy it back at a lower
price than you sold it for.
b. If stock price increase you will lose
money because you must replace the
borrowed stock with stock purchased
at a higher price.
B. Long-Term Techniques
1. Investing in the stock market for short-term
gains can be extremely risky, most financial
consultants advise you to invest for the long
term
2. Buy and Hold—if you buy and hold stocks for
many years, you can ride out the down times.
A profit or loss only occurs when you sell the
stock.
3. Stock split—an increase in the number of
outstanding shares of a company’s stock.
4. A stock split lowers the selling price of the
stock, making the shares more affordable
and encouraging investors to buy more.
Long-Term Techniques
5,
6.
7.
Dollar-Cost Averaging technique involves the
systematic purchase of an equal dollar amount
of the same stock at regular intervals. The
investor makes a profit when the selling price
per share is higher than the average cost per
share.
Direct Investment—buying stock directly from
a corporation, avoid brokerage and other
purchasing fees.
Reinvesting Dividends—using dividends
previously earned on the stock to buy more
shares. Avoids broker fees and other costs of
receiving cash dividends.
III. Reading the Stock
Listings—p. 294
1. Columns 1 and 2 show the highest and
lowest price this stock sold for during
the year.
2. Column 3—Lists stocks alphabetically
by name (stock’s ticker symbol)
3. Column 4—shows the cash dividend per
share for the year in dollars and cents.
III. Reading the Stock
Listings—p. 294
4. Column 5—Yld % stands for percent yield, or the
percentage of the current price the dividends represent.
5. Column 6—P/E ratio (price/earnings ratio) is the price of a
share of stock divided by the corporation’s earnings per
share over the last 12 months. A key factor that serious
investors use to evaluate stock investments. Low P/E
indicates solid investment, high P/E indicates higher risk.
6. Column 7—shows sales in hundreds of shares from the
previous day—how many round lots of stock were bought
and sold. Multiply by 100 to get number of shares.
III. Reading the Stock
Listings—p. 294
7. Columns 8, 9, 10—show the highest, lowest, and
closing price for this stock on the previous day.
The closing price is the final price at the end of
trading for the day.
8. Column 11—net change—compares the closing
price today with the closing price of the day
before. Minus means price had gone down, plus
means price has gone up. Boldface means
price change > 5%.
9. Check the closing prices periodically to keep
track of your stock portfolio
IV. Stock Indexes
A. Stock Index—a benchmark that investors
use to judge the performance of their
investments e.g. Dow Jones Industrial
Average—average of the price
movements of 30 major stocks listed on
the NYSE
B. Provides a general overview of what
stock prices are doing in the stock
market as a whole.
C. Standard & Poor’s 500, NASDAQ
Composite Index